Where are the sovereign wealth funds?
When interviews for the print edition of Q4 were conducted in April through August 2008, sovereign wealth funds seemed like a potential source of stability in the global financial system, due to their large pools of available capital. But when credit markets froze and stocks tumbled, SWFs seemed to stay on the sidelines. Rachel Ziemba is an analyst with RGE Monitor specializing in the strategies of SWFs. She provides her perspective on what these funds have been doing during the global economic turmoil.
Q: What's going on with the sovereign wealth funds?
The first thing to say is that different sovereign investors have reacted somewhat differently and there may well be more variation going forward. But there are a couple of strands that we can draw out of their behavior over the last couple months.
Broadly we've seen sovereign wealth funds step away from the financial sector in contrast to what they did from November 2007 through January 2008 when they led the recapitalizations of US and European global banks. Perhaps because they had arguably overinvested in the sector and perhaps because I think they realized that they invested far before the bottom. The Qatar Investment Authority is an exception — it invested billions of dollars in Credit Suisse and Barclays this summer and fall.
In addition, over the last few weeks, as the financial crisis deepened and widened, it has started to have fundamental effects on the domestic economies that sponsor sovereign wealth funds. So we have seen the sovereign wealth funds of Russia, Qatar, Kuwait, China, and probably others invest more in domestic equities, or take stakes in domestic banks, or set aside assets to be able to do so.
Another reason we might have seen sovereign wealth funds being a little less active is that they're waiting for the dust to settle. Some of them have arguably sustained significant losses on a mark-to-market basis. Their stakes in financial institutions have definitely suffered losses. They're in most of these deals for the long haul, so they may end up winning on them; however, if looking at the performance of equity markets and alternative asset classes — hedge funds, private equity, real estate funds — in which many sovereign wealth funds increased their exposure over the last several years, those asset classes have performed very badly over the last year or so. In fact, based on research that we've done here at RGE Monitor the losses may have been so great that they almost erased the large inflows of capital from record oil prices. However, unlike hedge funds, sovereign wealth funds do not necessarily need to sell to raise cash, they tend to have long-term horizons.
Q: What else should we be watching for?
There may be some areas of significant activity. One trend over the last few years is that more and more sovereign investors are becoming more activist, in some cases that has meant taking on voting rights as Norway, Singapore’s Temasek, and others do. In fact the CIC’s recent stake in Blackstone reportedly includes voting rights unlike its previous stakes. Almost all countries that sponsor a sovereign wealth fund have, on average, increased the size of stakes they are allowed to take. And in the last year we've seen what I call government investment companies seeking out joint ventures and investing in sectors like financials, resources, auto/aerospace prioritized for domestic economic development. They may also be seeking out investments in land — real estate and agricultural — or natural resources.
Mubadala, which is an investor of the Abu Dhabi government, has probably been the leader in this. They seek out joint ventures with foreign companies, which may include investment or economic development opportunities for Abu Dhabi either today or down the line. A prime example of this partnership, which they see as a win-win for the company and the country, is the venture between GE and Mubadala in which they announced a partnership in alternative energy and a variety of other investments. I think that's an example of the start of the more domestic focus of some sovereign wealth funds. Singapore’s Temasek has long taken significant stakes in foreign companies, funding new acquisitions through partial privatization and occasional capital injections.
Furthermore even sovereign wealth funds started to raise money on the international capital markets or invest in leveraged funds, so they too may have to reassess strategies. Some investments assumed continued easy access to debt financing, which means their costs could now be very high.
Q: Could you say more about the domestic focus?
Some investment funds are primarily stabilization funds, there to build up reserves that provide a buffer to guard against dependence on a volatile commodity. That's why many sovereign wealth funds have a smaller stabilization fund embedded into them – the Kuwait Investment Authority, for example, manages both a long-term-oriented fund, the Fund for Future Generations, and a shorter-term fund, the General Reserve Fund. The value of the stabilization fund ebbs and flows according to budgetary needs. The savings funds tend to have a longer-term focus.
For many countries, it's the stabilization purpose that's getting the upper hand for the moment. Russia, for example, is putting aside hefty sums of money, either directly or indirectly, to support their banking sector and their corporations.
For quite some time, as credit markets froze and financial market conditions worsened in the U.S. and then the G7, liquidity was still fairly ample in many emerging markets. The tightening of liquidity became evident in the Middle East, especially in the UAE and Qatar and maybe even Saudi Arabia earlier this summer, when project finance became very expensive. The domestic focus in part has been a realization that instead of investing abroad, they want to cushion the domestic economies that are being very profoundly affected by the global economic and financial crisis
Q: French President Sarkozy proposed that European countries create sovereign wealth funds focused on supporting and protecting key domestic industries. What do you make of the proposal?
I think the real problem with that idea is that, with a couple of exceptions, sovereign wealth funds originate from countries that have savings they are looking to both steward and grow. Most European countries actually run current account deficits. They're net importers of capital. Where would they get the money to form a sovereign wealth fund? They could raise funds through a levy, in a sense raising funds through taxes, or they could use selective privatization and then invest the proceeds, but that would seem to defeat the purpose that Sarkozy has in mind of protecting French and other European countries from foreign investors.
Sarkozy is worried that foreign governments will swoop in and purchase stocks when they're cheap and when it's all over everyone will wake up to see they've mortgaged the economy. Arguably, the goals that Sarkozy ultimately wants to achieve might be achieved better through appropriate regulation and enforcement of those regulations rather than restricting investment. For example, it probably matters a little bit less who owns a company than whether it is effectively regulated and whether the owner operates within those parameters.
But I do think there has been a growing sense of unease about foreign companies and governments taking on large stakes. Italian officials have been talking about a 5% limit for some foreign investment. Germany is about to pass a law that restricts foreign ownership. However, no European country has a CFIUS-like law. [CFIUS is the Committee on Foreign Investment in the United States. It reviews national security implications of foreign investments in the U.S.]
I would say many of the concerns are more about state-owned enterprises from countries like Russia and China than they are about sovereign wealth funds. Many European countries look to the example of Gazprom, Russia's natural gas company, which has a history of shutting off the natural gas pipeline and has taken a large stake in distribution arms. The more that we've learned about sovereign wealth funds, the more they seem like comparable private sector actors, primarily institutional investors like pension funds or endowments.
In March, the EU really threw its weight behind the IMF-led process to increase transparency and disclosure and best practices. But its attempt, procedurally in my view, was to forestall more protectionist responses, almost a race to the bottom of protectionism, by some of the European countries.
The question mark will be how significant the recently released Santiago principles, which grew out of this process, become. They are on the one hand detailed and on the other hand vague. Figuring out exactly what it means to comply with this fairly substantial set of voluntary principles, has yet to be determined. But they will likely become a benchmark that funds have to meet and a key part of a trust-building process that has been taking place for some time.
Two years ago, barely anyone was talking about sovereign wealth funds. Over the last year it has become a household term. But in the U.S. and many European countries there's still a gut worry about the role of these investors, both because they are foreign governments and because of which foreign governments dominate.
Q: After seeing protectionist responses from some countries, have sovereign wealth funds looked to parts of the world where they're more welcome?
Protectionist sentiments concern sovereign wealth funds especially because they create uncertainty. One of the biggest challenges for investors is the possibility that the investment climate is going to change and a deal that seemed like it was going to go through fails. Like any investor, sovereign wealth funds don't want to go where they're not wanted. But ultimately sovereign wealth funds make an investment based on whether they think it's a good economic decision, whether they can make a return.
Q: Are sovereign wealth funds, over all, smaller and less important than the attention that's been paid to them?
The estimates for the rates of sovereign wealth growth were probably overly optimistic even before the financial crisis. Given the economic climate that we're entering into, they will likely turn out to be particularly overoptimistic. About three quarters of the total stock of sovereign wealth fund assets stock comes from oil funds and with the fall in the price of oil and likely smaller surpluses in export-led economies in Asia, the capital that has funded the growth of sovereign wealth funds will probably be much smaller for the next couple of years.
Interview conducted and edited by Ted O’Callahan.